Abstract

Economists often favor market-based mechanisms (e.g., auction) over non-market based mechanisms (e.g., lottery) for allocating scarce public resources on grounds of economic efficiency and revenue generation. When the usage of the resources in question generates negative externalities that are increasing in willingness-to-pay (WTP), the welfare comparison can become ambiguous. Both types of mechanisms are being used in China's major cities to distribute limited vehicle licenses as a measure to combat worsening traffic congestion and urban pollution. While Beijing employs non-transferable lotteries, Shanghai uses an auction system. This paper empirically quantifies the welfare consequences of the two mechanisms by taking into account both allocation efficiency and automobile externalities post-allocation. Our analysis shows that different allocation mechanisms lead to dramatic differences in social welfare. Although the lottery system in Beijing has a large advantage in reducing externalities from automobile use than a uniform price auction, the advantage is offset by the significant welfare loss from misallocation. The lottery system forewent nearly 36 billion RMB (or $6 billion) in social welfare in Beijing in 2012 alone. A uniform-price auction would have generated 21.6 billion RMB to Beijing municipal government, more than covering all the subsidies to the local public transit system.